tv Bloomberg Real Yield Bloomberg August 24, 2018 7:30pm-8:00pm EDT
>> from new york city, for our viewers worldwide, i am jonathan for 30 minutes dedicated to fixed income. this is "bloomberg real yield." [captioning performed by the national captioning institute, which is responsible for its caption content and accuracy. visit ncicap.org >> coming up, jay powell forging ahead with grad way sbrate hawkeyes. president trump reporting that america is willing to buy italian detriment and cracks appearing in one of the best performs pockets this year. we begin with this. fed speaks in jackson hole. >> we ought to be moving toward neutral, which means three or four increases over the next 9-12 months, and i think at this point moving in september
and december is consistent with that path. >> from my point of view i would rather not be calling rates accommodative right now. i think the whole structure of rates is lower. thorough forei think we are at neutral or close to neutral right now. >> i agree the economy is doing well. i think two more rate hawkeyes this year could be appropriate. >> the case for raising rates is compelling. we have an economy growing above trend, and inflation at basically our goal of 2%. >> there is no reason to challenge the yield curve at this time. there is no reason. >> i would also remind you this is not our obtive to manage the yield curve. we use it as a signal to tell us about our policy path. >> joining us is bloomberg's international and economics mckee. ndent, michael walk me through what we have learned? >> i think what we have learned
is that we are going to see the fed raise rates in september, and probably in december. he made the case that there are people arguing the fed should move faster because the economy is picking up speed and there are people who make the case that with no inflation in sight, fed could move at a slower part. he picked the middle route and say gradual increases is justified as this time. no indication that he would change. no list of problems out there that we saw in the minutes that might influence them. pretty much this is what we are doing, and we are going to keep doing it. >> from beautiful jackson holliday, michael mckee. joining me around the table is matt, global head of separate strategy of morgan stanley, and the managing director of head of u.s. rate strategy. and coming to me from atlanta, is rob, chief strategist and head of fixed incomes.
>> it seems like it is chair powell saying more of the same at the same pace. >> yes. i think the message is very clear. it is one of caution and grads walism. wallism. -- grad basically they have been hiking once a quarter, and there is notice reason to squeeze in a lot of hikes over the coming year. they are going to be cautious, assess every meeting if more hikes are warranted, and then proceed as required. >> matt, it seems they are just trying to take the price action and trying to explain away and link it back to jackson hole, wyoming. forget the dollar a moment, there is nothing that has changed from jackson hole and nothing change the from chairman powell from the month before that and the month before that. >> that is right. the market probably got ahead of itself trying to make up the story for the fed hiking. he wasn't super hawkish.
at the end of the date when you look at what he is telling the mark place, he is saying we are going to continue to gradly raise rates. there is no reason for them to change course at this point. >> what was your take? >> well, our take on chairman powell's speech is that he is going to continue with this gradual rate increase. what i was surprised by is he didn't really talk about the yield curve at all. he highlighted the difficulty of understanding economic data and how unemployment is relating with inflation, and how difficult it is to measure that. but the yield curve you could gue is easy to measure and easy to see. >> where do you think he should be look something should he be looking at fed funds race out to 10. where is the most important part of the curve that gives you the most information on what they should be doing? >> they are correlated. place 20 's is a good
look. we reached a new flat in those levels. if they continue with their steady rate increase, we would expect that to continue to flaten. >> i think the market wants to look at 2's and 10's and 530. but the fed looks at the general part of the curve. that has been a good indicator of whether there is going to be a slow-down in growth a year after the curve flatenses. >> there was an interesting fed study out saying the 2's 10's part of the curve is not the best cator to look at. you are supposed to be looking at the front end of the yield curve because that does a better job of foreshadowing the next recession. but at the end of the day, these yield curves are core late, so we should be watching everything. >> it seems there is correlation there that you can't deny, but for the federal reserve chairman, he is saying
i don't believe in the causation, and there seems to be a debate over that. >> absolutely. listening to kaplan speak at jackson hole, he emphasized the idea that the long end of the curve is telling them that growth is going to slow. look at what the fed is doing. they are higing interest rates. of course the market is going to think that growth is going to slow. it is amazing to me they have ssed this fundamental rate that hiking rates leads to slower growth. >> do you think the flattener is here to stay? >> yes. there is no real risk of run away inflation. inflationary expectations have 210 and 220. ween the back end is pretty much relatively -- it is going to be range bound, and a lot of the pressure is going to come on front front end. this dynamic with the flattening led by the front end
is going to remain for the remainder of the cycle. >> is it the right trade for you? >> i agree that the risk for run away inflation is not really in the market. break evens have been steady times.umber of >> what was interesting about powell's speech was he told us he wasn't worried about up side risk to inflation, and yet he would continue to race rates. that is a recipe for a flatter curve. we will invert next year. >> it is not up side inflation risk and financial instability and excesses. is that what a driving the federal reserve chairman? >> i don't think so. if they were really worried about financial access, they would be hiking more than once a quarter. they are not there yet, and it is unlikely they will get there. >> the other discussion is the neutral rate. they are about to move into the
range of neutral. what is neutral? >> it is hard to say. if you look at the fed's forecast of where the neutral rate should be, they have been a rate of 2.3% and 3.5%. it is between there. we won't know until well after the fact. so i would say it is safe to assume, given the median expectations where the neutral fed funds rate is somewhere between 2.5% to 3%. >> your view? >> i would say we believe the neutral fed fund rate is probably below that. what is interesting is chairman powell today did talk about how exactly -- how difficult it is to determine what that is. but i think if we look at the risk/reward here for the fed, i would think the risk/reward favors letting the economy run a little bit to try and find out where that neutral rate is rather than hunting for the neutral rate before you get inflation. >> one thing i picked up from chair powell's speech is he
seems to be more focused on the unemployment picture than inflation. that will lead them to determine where neutral is. they need to see the unemployment rate flat line for a period. it seems like it is still on a downward trajectory. the fed expect the unemployment rate to continue to fall. they are going to wait until that stabilizes. >> they have talked about a removal of accommodation. they are about to consider what restrictive policy looks like. what does it mean for the treasury market, matt? >> i think the important thing here is what the fed is telling market they are likely to do. this is where the dot plot comes into play. it is an important signaling mechanism to the markets place. in september when they gather around the table and they come up with their dots and figure out where they are going to be, they have released them to the marketplace. the market is going to look at the where are the 2020 doots? where are the to 21 dotes? that is important.
guidance n't had much around the balance sheet from the fed reserve or the championship himself? >> for the first time, at least in my career, we saw the reference from the chairman himself in the minutes calling for having to look at the balance sheet in the fall. i think that is going to be at the top of the agenda. what changed is we are going to go from an autopilot type mode of the last two years, to being careful about the side of the balance sheet, what the exit reserves should be, given the facts we are in a completely different regime post crisis. maybe it warrants a higher balance sheet and exe reserves. there is is a lot of regulatory demand for excess reserves. those are the kind of discussions we are going to get from the fed in the fall. >> rajappa sticking with me, along with our two other
>> i am jonathan. this is "bloomberg real yield." i want to head to the auction block. we start in the united states. the treasury selling $14 billion of five year at yield of of -- at a 7.25%. daimler issued its second round of pound bovends, parking a 40% slump in corporate debt sales in 2018. the mercedes-benz priced the
notes to yield 2.033%. staying in europe. u.s. companies have cut investment great notes to 0%. removed an incentive to issue debt in europe. i want to get to a fascinating story. we have a mention of a report that says president trump told italian prment that the u.s. is willing to help the country by buying government bond next year. still with me is matt from and other our guests. everyone who has read that story has laughed. how could this happen? >> it can't. as far as i know, the u.s. government doesn't have the ability to go out and buy sovereign debt from other countries, even though the federal reserve has a very limited capability of buying securities.
they can't go out and buy equities in the u.s. they can in japan, but the u.s. is limited. >> the only thing i would say here is if it actually happened, it would be a great deal if they swapped back the currency. you can get some great yields in italian debt. >> let's c's over to rob. your thoughts on this? i think most people say it doesn't happen. it is quite clear the united states is willing to back it'sry when italy is pushing europe to arow them to spend more money. >> don't think it will happen en. he is offering help just at the time with the fed tightening policy and the u.s. administration pushing hard on this trade. we saw other stories today about renewed tariffs. all of those are going to make it murphy more difficult for italy and emerging markets. on the other side he is talking
about buying italian fonds. he is talking about the fed put, which is very far away from where we are now. it is interesting we get this die cot my. >> it is interesting, but in the european bond market, i want to put you on the spot and ask you how wide italy stays relative to germany. yield have stayed blown out. the extreme risk is redomination risk. the base case is an increase of supply. is that your base case? >> we have to get through budget negotiations in italy. i think there is going to be continued noise from italy as we come back from summer vacation. that is what is keeping spreads wide. we don't see the redomination risk prop gating throughout the euro zone because the pressure is really on italy. at this point it is on italy. if it starts to impact some of these other more vulnerable countries like spain, then you would start to be thinking about redenomination risks.
>> the e.c.b. still hasn't finished q.e., and yet we already have concerns about b. t.b.'s. >> one of the focus areas for the e.c.b. is this through the summer commitment on separates. how can we be talking about raising interest rates at all when you have these things happening in europe? people will kind of give italy the benefit of the doubt for now. clearly spreads have widened, but i think next year it is going to be very interesting when we talk about e.c.b. policy, how they manage the situation. >> and who leads the central bank as well. reports from germany that act la merkel is pushing for the top spot of the commission to be filled with a early german. i imagine there are bulls on the periphery that may be happy with that situation. matt, great to have you with us on program, jabanna and rob. we want to go to mark chess, of of 2 eagles, 10's and 30's have
>> i am jonathan ferro. this is "bloomberg real yield." i want to get you up to speed on what is coming up through the rest of the week. there is trade data from the united states as we get insight into how the tariffs between china and the united states might be affecting the numbers. look out for all of that, u.s. trade data coming on tuesday. and we get some u.s. g.d.p. working out on wednesday. look out for that as well.
and housing and personal spending data, the u.s. personal income data dropping on thursday. i want to get to a big debate that has happened in the fixed income market in 2018. two pockets that have outperformed. one is high yield, and the other is leverage loges. but leverage loans have been outperforming high yield. i was hope to catch up with two people on different sides of the trade. one is cris of oppenheimer funds. we asked them whether either side has room 0 rub. take a listen to what they have to say. >> i think the leverage lone trade is not going -- because you are going to make a money -- a lot of money on it. you get decent income. if things turn south, then the protection you have because of seniority is going to be very significant. i think it is fair to say that the supply of loans has been somewhat of a problem where you see lots of issuers coming into the marketplace who wouldn't
have come in normally. but i think if you have an actively managed fund where you pick the right securities in a down cycle, loans will distinguish themselves. >> how did that work out in 2018? not very well. high yield was down about 26%, and loans were down 31%. we are just seeing the pattern we have seen over the past few years. it is that companies that really should be coming to the high yield market and issuing at 6% to 8%, go to the lone market because the financing is much cheaper there. people think we are talking about the same universe of companies. we are not. two of three lone issuers don't have bonds under them. >> so it is not what you think it is. it is not high quality? >> i think he mentioned 2018. he ought to mention 2019 as well. what happened in 2009? loans came back a lot faster. that is precisely the point. you can have a draw down, but because loans of senior and because you have significantly lower losses in good loans.
>> you are talking about high recovery rate. >> high recovery rate, and you have confidence, and companies that issue in the lone market that may not be able to issue in the high yield mark at all. >> i don't understand that argument. they h twain twain, killed high loans. when the 10-year was below 1.5%. this is the second year out of the last 13 that loans have beaten high yield. when the 10-year treasure was was under 1.a%. high yields burn 7% analyzed, loans 4%. following this vice over time continually loses you money versus the alternative. >> again, let's not cherry pick the last two years. let's go back when we had the downturn where the driver of downturn was a problem in the
high yield mark. let's look at the recovery, the 2002-2003 time frame, and the performance of the high yield market in that time frame was significantly worse than the performance of the lone market. if you are not going to cherry pick the data, let's not just pick the last 0 years. it is also fair to say that even the most ardent high yield investor today is surprised by the performance of high yield this year. it is absolutely clear in the marketplace. i think the up side in high yield is relatively modest. everything said that, i think the debate between lone and high yield is irrelevant in my mind for this reason. the real isn't isn't between picking between high yield and loans. the real opportunity is really in emerging market local debt. if i had some money to put to work today for significantly better returns, it wouldn't be because i want to devote loans or high yield. it would be buying emerging market local debt, which is
extraordinarily cheap at the moment. >> that is something we can definitely agree on. >> i finally got you on the right side, we are going back now. >> but it is irrelevant. over the past year, loans have edged a small win. rolling, two, five, 10, 20 years, any year you want, they killed them. you have no up side like you have on the high yield market. >> i want to get to your conviction of high yield in the united states. lk me through why people are that way some >> people are very over wait. u.s. high yield, european high healed, bank loans, emerge thing market debt. there is nothing in the portfolio for a rainy day. >> a debate on two others of fixed income that have really outperformed this year. verage loans outperforming